Income Inequality and the Economy: The Impact on Workers and Consumers

Education and productivity are critical in addressing growing income inequality and related ills, according to speakers at a recent Federal Reserve Bank of Atlanta discussion.

Research from numerous sources, including the Federal Reserve Board, suggests that the distribution of income and wealth in the United States has widened steadily since about 1980. Causes of rising inequality and possible solutions are complicated. But better education and job preparedness—which conceivably leads to higher worker productivity and thus higher wages—are keys to addressing the problem plaguing middle- and lower-income earners, speakers at the Atlanta Fed's September 13 Public Affairs Forum said.

Listen to our podcast interviewing Steven Fazzari of Washington University about income inequality.Transcript

Steven Fazzari, left, and Stuart Andreason

Knowledge is power
One of the roots of lagging wage growth among middle- and lower-income earners is a lack of understanding of rapidly changing labor market demands, said Jim Shelton, president of education at the Chan Zuckerberg Initiative, the philanthropic foundation formed by Facebook founder Mark Zuckerberg and his wife, Priscilla Chan. This confusion translates into a lack of preparation for the better-paying jobs of today and tomorrow, Shelton and Washington University economist Steven Fazzari explained at the Atlanta Fed event. A lack of knowledge about quality jobs and the skills those jobs demand has led increasing numbers of potential workers to quit the labor force in despair.

This set of circumstances presents daunting challenges. Giving people marketable skills through training and schooling seems to be a big part of the answer, the panelists noted.

Shelton cited a few highly successful workforce development and educational programs. For example, the U.S. Navy undertook an intensive program to upgrade its shipboard information technology support staff. In the course of 18 weeks, the Navy vastly improved the technical capabilities of small groups of new recruits, mostly high school graduates with no college. Likewise, Shelton cited the dramatic results from an innovative one-on-one tutoring program among struggling public school students.

An important element in such programs is giving people not just knowhow, but hope, Shelton said. He noted a typical quote from a new Navy IT professional: "I never knew I was smart."

Still, the initiatives Shelton mentioned involve small groups and would likely be difficult and expensive to duplicate on a massive scale. "It can be done," Shelton said. "We just need to do a lot more of it."

Technology can help. Online offerings extend tutoring services to far greater numbers of students, Shelton pointed out. He said most young people today can go online to satisfy the innate human need for connection and feedback. Yet technology also presents challenges. Take Facebook, a contemporary corporate star, and auto makers, pillars of past prosperity. The social media company grew from a few smart people devising something incredibly popular that can be spread to millions of users at little marginal cost and with relatively few employees. Fazzari contrasts that with automotive companies whose assembly plants were hugely expensive but created many thousands of jobs.

To illustrate the changing nature of business success and labor markets, The New York Times recently noted that in 2016 Apple, Facebook, and Alphabet (Google's parent company) produced combined revenue of $333 billion with 205,000 employees. In 1993, the Times reported, three of the nation's most successful technologically oriented firms—IBM, AT&T, and Kodak—employed more than three times as many people, 675,000, to generate about a fourth less in inflation-adjusted revenue.

Expanding the overall economic pie is critical, Fazzari said, adding that it's important to "make work pay." At the same time, he added, understanding that not everyone is going to be a software engineer is essential. "I don't believe we will solve these problems by training everybody to be what is at the top 5 percent of the income distribution right now," Fazzari said.

In fact, many jobs still don't require a college education—70 percent of U.S. adults, after all, do not have a bachelor's degree—and some of those jobs pay reasonably well. On the whole, though, those workers ideally should be better compensated perhaps via a higher federal minimum wage or tax policy changes focused on the middle class, he said.

A change in thinking might also help. Atlanta Fed President Raphael Bostic and Fazzari agreed that training programs for trades are not as prominent as they might be, and that many parents steer their kids away from trades that pay a good wage, such as plumbing and electrical work, because they perceive them as blue collar and therefore undesirable.

Inequality could be restraining economic growth
Inequality may be hurting everybody. There are signs that worsening inequality is a drag on the larger economy, contends Fazzari.

He pointed to a recent downturn in annual per capita gross domestic product growth from the peak of one economic cycle to the peak of the next. Annual growth in the period from the fourth quarter of 2007, before the Great Recession, through the second quarter of this year, averaged 0.6 percent, about a third of the average pace of growth during four previous cycles dating to the 1970s.

What role has income inequality played in restraining growth? Fazzari likens the economy to a huge recycling machine: people work and earn money; they spend money that goes to other businesses; those firms in turn hire workers who spend, and the cycle repeats.

Inequality, in Fazzari's view, slows that machine because workers in the middle and lower part of the income distribution spend a greater proportion of their earnings than do those at the top of the scale, and the middle- and lower-income earners vastly outnumber high earners. So as a greater share of income is concentrated among fewer people at the top, there is less spending by the masses in the middle and the bottom, thus jamming the gears of the larger economy's recycling mechanism.

Like Fazzari, many researchers maintain that a greater concentration of income among top earners could affect the overall economy by dampening consumer spending and overall demand. Still, the consensus among economists is that more research is necessary to determine the direct economic effects of inequality. "We're going to continue this conversation here," Bostic said in concluding his first Public Affairs Forum as Atlanta Fed president.